Small Business Management Chapter 4 PowerPoint

© 2020 Cengage Learning®. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part.
CHAPTER
4
Franchises
and Buyouts

LEARNING OBJECTIVES
By studying this chapter, you should be able to…
4-1 Define franchise, and have an understanding of
franchising terminology.
4-2 Understand the pros and cons of franchising.
4-3 Describe the process for evaluating a franchise
opportunity.
4-4 List four reasons for buying an existing business,
and describe the process for evaluating an existing
business.

4-1 WHAT IS A FRANCHISE?
• The Singer Sewing Machine company is credited with
being the first franchisor in the United States.
• In 1851, Albert Singer entered agreements with local retailers
to give them exclusive rights to sell Singer sewing machines.
• Some historians, however, contend that Benjamin
Franklin was actually the first U.S. franchisor.
• They cite the arrangement he made with a printer in South
Carolina to reproduce Poor Richard’s Almanac columns.
• Franchise – The right to sell the licensing company’s
goods or services in a particular area.

4-1a Franchising Terminology
(slide 1 of 4)
• Franchising – A process for expanding a
business and distributing goods and services
through a licensing relationship.
• Franchisor – The party in a franchise contract
that specifies the methods to be followed and
the terms to be met by the other party.
• Franchisee – The party in a franchise contract
that is granted a license to do business under
a particular trademark and trade name by the
franchisor.

(slide 2 of 4)
• There are two primary forms of franchising:
1. Product and trade name franchising – A
franchise agreement granting the right to use a
widely recognized product or trademark.
• Automobile dealers and convenience stores are examples
of companies engaged in this type of franchising.
2. Business format franchising – A franchise
arrangement whereby the franchisee obtains an
entire marketing, management, and supply system
geared to entrepreneurs.
• Quick-service restaurants, hotels and motels, and
business services typically engage in this type of
franchising.

(slide 3 of 4)
• In order to become a franchisee, you will need to enter
into a legal contract with the franchisor.
• Franchise contract – The legal agreement between
franchisor and franchisee.
• The contract spells out your relationship and obligations to
each other.
• Before you sign the agreement, the franchisor must
provide you with a Franchise Disclosure Document.
• Franchisors establish organizational structures and
designate employees or partners to expand the
number of franchised outlets and to monitor their
performance.

(slide 4 of 4)
• The most frequent means for carrying out growth strategies are
through use of the following:
• Master licensee – An independent firm or individual acting as a
middleman or sales agent with the responsibility of finding new
franchisees within a specified territory.
• Multiple-unit ownership – Ownership by a single franchisee of more
than one unit of the franchised company.
• Area developers – Individuals or firms that obtain the legal right to
open several franchised outlets in a given area.
• Piggyback franchising – The operation of a retail franchised outlet
within the physical facilities of a host store.
• Multibrand franchising – The operation of several franchised
businesses within a single corporate structure.
• Co-branding – Bringing two or more franchise brands together within
a single enterprise.

4-1b The Impact of Franchising
• In 2016, franchising was estimated to provide direct
employment in 801,153 franchise establishments,
totally nearly 9 million jobs.
• Revenues generated by these businesses amounted
to $868.1 billion, accounting for 3.4 percent of the
nonfarm gross domestic product of the United States.
• These figures underestimate the full impact of
franchising on the economy, however, because
franchising stimulates activity and generates growth in
many nonfranchised businesses, such as suppliers
and lenders.

4-2 THE PROS AND CONS
OF FRANCHISING
• There are both advantages and disadvantages
to the franchise model.

4-2a The Pros of Franchising
• Perhaps the most fundamental argument in support of the
franchise model is that it reduces the level of risk for business
owners.
• Other advantages of franchising include the following:
• Established, reputable franchisors offer business models with proven
track records.
• Attractive franchisors offer value because they have names and
trademarks that are well known to prospective customers.
• When a new franchisee comes on board, franchisors provide detailed
operations manuals that explain the specific steps required to operate
the enterprise profitably.
• Franchisors support their franchisees by providing training, reducing
purchasing costs, designing promotional campaigns, and assisting in
obtaining capital.
• Franchising can be a way for existing companies to diversify.
• A number of franchisors provide or facilitate financing for franchisees.

4-2a The Cons of Franchising
• Disadvantages of franchising include the following:
• Financial issues.
• Example: Being mislead about earnings opportunities.
• Churning – Actions by franchisors to void the contracts of
franchisees in order to sell the franchise to someone else and
collect an additional fee.
• Encroachment – To sell another franchise location within the
market area of an existing franchisee.
• Management issues.
• A franchisee has a contractual arrangement with the franchisor
that stipulates various conditions on how the business is run;
thus, the franchisee is not a truly independent business owner.

4-2c The Costs of
Being a Franchise
• Costs associated with franchising include:
• The initial franchise fee.
• This may range from several hundred to many thousands of dollars.
• Investment costs.
• These include rental or building costs, inventory and equipment
costs, insurance premiums, legal fees, and other startup expenses.
• Royalty payments.
• A royalty is a fee charged to the franchisee by the franchisor.
• It is calculated as a percentage of the gross income that the
franchisee receives from customers for selling the franchised
products and services.
• Advertising costs.
• Many franchisors require that franchisees contribute to an
advertising fund to promote the franchise.
• These fees are generally 1 to 2 percent of sales.

4-3 EVALUATING
FRANCHISE OPPORTUNITIES
• Both the franchisee and the franchisor must
fully assess a decision to pursue a franchising
opportunity.
• The prospective franchisee must identify a
franchising company of interest and investigate it
completely.
• A potential franchisor who is interested in
expanding his or her business must address certain
questions before offering the franchise option to
possible franchisees.
• Both parties to a franchise agreement must have
knowledge of the legal issues involved.

4-3a Selecting a Franchise
• With the growth of franchising over the years,
the task of selecting an appropriate franchise
has become easier.
• Personal observation frequently sparks interest,
or awareness may begin with exposure to an
advertisement in a newspaper (such as The
Wall Street Journal) or magazine (such as Inc.
or Entrepreneur) or on the Internet.

4-3b Investigating the
Potential Franchise (slide 1 of 2)
• A potential franchisee should consider asking the following
questions when assessing different franchise opportunities:
• Is the franchisor dedicated to a franchise system as its primary means
of product and service distribution?
• Does the franchisor produce and market quality goods and services for
which there is an established consumer demand?
• Does the franchisor enjoy a favorable reputation and broad acceptance
in the industry?
• Will the franchisor offer an established, well-designed marketing plan
and provide substantial and complete training to franchisees?
• Does the franchisor have good relationships with its franchisees?
• Do franchisees have a strong franchisee organization that has
negotiating leverage with the franchisor?
• Does the franchisor have a history of attractive earnings by its
franchisees?

4-3b Investigating the
Potential Franchise (slide 2 of 2)
• Independent third parties such as state and federal government
agencies, the International Franchise Association, and business
publications can be valuable sources of franchise information for
potential franchisees.
THE FRANCHISOR AS A SOURCE OF INFORMATION
• The primary source of information about a franchise opportunity is
the franchisor.
EXISTING AND PREVIOUS FRANCHISEES AS SOURCES OF
INFORMATION
• Existing and previous franchisees are also good sources of
information.

4.1 Profile from International Franchise Association (2018)

4-3c Becoming a Franchisor
• If you are thinking about becoming a franchisor,
consider:
• The efficiency of your business model.
• How you will finance growth.
• What expert assistance you will need.
• The content of your operations manual.
• Government disclosure requirements.
• Franchise Rule – A rule that requires the franchisor to
disclose certain information to prospective franchisees.
• Your ability to add long-term value for franchisees.

4-3d Legal Issues in Franchising
(slide 1 of 3)
THE FRANCHISE CONTRACT
• The basic features of the relationship between the
franchisor and the franchisee are embodied in the
franchise contract.
• The franchise contract is typically a complex document
of many pages.
• Because of its importance, the franchise contract should
never be signed by the franchisee without legal counsel.
• A prospective franchisee should also use as many other
sources of help, such as a banker and a professional
accounting firm, as would be practical.

(slide 2 of 3)
• One of the most important features of the franchise
contract is the provision relating to termination and
transfer of the franchise.
• The prospective franchisee should be wary of contract
provisions that contain overly strict or vague cancellation
policies.
• Similarly, the rights of the franchisee to sell the business to a
third party and the rights to renew the contract after the
business has been built up to a successful operating level
should be clearly spelled out.

(slide 3 of 3)
FRANCHISE DISCLOSURE REQUIREMENTS
• The offer and sale of a franchise are regulated by both
state and federal laws.
• At the federal level, the minimum disclosure standards are
specified by the Franchise Rule.
• Franchise Disclosure Document (FDD) – A detailed
statement providing information about the franchisor that
satisfies the franchise disclosure requirements of the FTC.
• The FDD provides information such as the franchisor’s
finances, experience, size, and involvement in litigation.
• The document must inform potential franchisees of any
restrictions, costs, and provisions for renewal or cancellation of
the franchise.

4-4 BUYING AN
EXISTING BUSINESS
• The decision to purchase an existing business
involves a serious investment of funds, so
careful consideration must be given to the
advantages and disadvantages of this option.

4-4a Reasons for Buying
an Existing Business
• The reasons for buying an existing business can be
condensed into the following four categories:
1. To reduce some of the uncertainties that must be faced when
starting a business from the ground up.
2. To acquire a business with ongoing operations and established
relationships with customers and suppliers.
3. To obtain an established business at a price below what it
would cost to start a new business or to buy a franchise.
4. To get into business more quickly than by starting from scratch.

4-4b Finding a Business to Buy
• Sources of leads about businesses available for
purchase include suppliers, distributors, trade
associations, and even bankers.
• Realtors—particularly those who specialize in the sale
of business firms and business properties—can also
provide leads.
• In addition, business brokers can assist in buying and
selling businesses.
• Business brokers – Specialized brokers that bring together
buyers and sellers of businesses.

4-4c Investigating and Evaluating
Available Businesses (slide 1 of 3)
• Due diligence – The exercise of reasonable
care in the evaluation of a business opportunity.
• Some of the steps in the due diligence process are:
• Identify legal obligations, such as outstanding judgments or
tax liens.
• Make sure all licensing, permits, and zoning requirements
are met.
• Review all existing contracts with suppliers and employees.
• Verify that the company owns all the assets listed on the
balance sheet.
• Review accounting practices, revenue, inventory
management, accounts receivable, and previous tax returns.
• Determine the value of the business.

RELYING ON PROFESSIONALS
• A buyer should seek the help of outside experts,
especially accountants and lawyers.
FINDING OUT WHY THE BUSINESS IS FOR SALE
• The buyer needs to investigate why the seller is offering
the business for sale.
• The seller’s real reasons for selling may or may not be the
stated ones.
• A prospective buyer cannot be certain that the seller-owner will
be honest in presenting all the facts about the business,
especially concerning financial matters.

EXAMINING THE FINANCIAL DATA
• The company’s financial statements and tax returns for
the past three to five years (or longer) should always be
examined.
• The buyer should recognize that financial statements can be
misleading and may require normalizing to yield a realistic
picture of the business.
• As both a legal and an ethical matter, the prospective
buyer may expect to sign a nondisclosure agreement.
• Nondisclosure agreement – An agreement in which the buyer
promises the seller that he or she will not reveal confidential
information or violate the seller’s trust.

4-4d Quantitative Factors in
Valuing the Business
• Once the initial investigation and evaluation have been completed,
the buyer must arrive at a fair value for the firm.
• To do so, the buyer will want to review supporting materials that
validate the accuracy of the financial statements, such as state sales
tax statements, supplier invoices, customer receipts, and the
company’s bank statements.
• There are numerous techniques used for valuing a company, but
they can be grouped into three basic methods:
1. Asset-based valuation.
2. Market-based valuation.
3. Cash flow–based valuation.
• Each of these methods can be used as a stand-alone measure of
firm value, but because valuation is a subjective process, most
often the firm is valued using a variety of methods.

4-4e Nonquantitative Factors in
Valuing a Business (slide 1 of 3)
• Nonquantitative factors in determining the value
of a business for sale include:
• The market.
• The ability of the market to support all competing business
units, including the one to be purchased, should be
determined.
• This requires doing marketing research, studying census data,
and personally observing each competitor’s place of business.
• Competition.
• The prospective buyer should look into the extent, intensity,
and location of competing businesses.
• In particular, the buyer should check to see whether the
business in question is gaining or losing in its race with
rivals.

• Future community development.
• Future developments in the community that could have an
indirect impact on a business include:
• A change in zoning ordinances already enacted but not yet in
effect.
• A change from a two-way traffic flow to a one-way traffic flow.
• The widening of a road or construction of an overpass.
• Legal commitments.
• Legal commitments may include:
• Contingent liabilities.
• Unsettled lawsuits.
• Delinquent tax payments.
• Missed payrolls.
• Overdue rent or installment payments.

• Union contracts.
• The prospective buyer should determine what type of labor
agreement, if any, is in force, as well as the quality of the
firm’s relationship with its employees.
• Buildings.
• The quality of the buildings housing the business should be
checked, with particular attention paid to any fire hazards.
• In addition, the buyer should determine whether there are
any restrictions on access to the buildings.
• Product prices.
• The prospective owner should compare the prices of the
seller’s products with those listed in manufacturers’ or
wholesalers’ catalogs and also with the prices of competing
products in the locality.

4-4f Negotiating and
Closing the Deal (slide 1 of 3)
• The purchase price of a business is determined by
negotiation between buyer and seller.
• Although the calculated value may not be the price eventually
paid for the business, it gives the buyer an estimated value to
use when negotiating price.
• In some cases, the buyer may have the option of
purchasing the assets only, rather than the business as
a whole.
• When a business is purchased as a total entity, the buyer not
only takes control of the assets but also assumes any
outstanding debt, including any hidden or unknown liabilities.
• If the buyer instead purchases only the assets, then the seller is
responsible for settling any outstanding debts previously
incurred.

• An important part of the negotiation process is
the terms of purchase.
• In many cases, the buyer is unable to pay the full
price in cash and must seek extended terms.
• At this point, a lender may enter the picture and alter the
purchase price.
• If a bank is providing a loan for buying the business, the bank
may require the assets of the company to serve as collateral
for the loan.
• Terms may become more attractive to the buyer and
the seller as the amount of the down payment is
reduced and/or the length of the repayment period is
extended.

• As with the purchase of real estate, the purchase of a
business is closed at a specific time, and a title
company or an attorney usually handles the closing.
• Preferably, the closing will occur under the direction of an
independent third party.
• A buyer should never go through a closing without the aid of an
experienced attorney who represents only the buyer.
• Documents completed during the closing include:
• A bill of sale.
• Tax and other government forms.
• Agreements regarding future payments and related guarantees
to the seller.

Key Terms
area developers
business brokers
business format franchising
churning
co-branding
due diligence
encroach
franchise
franchise contract
Franchise Disclosure Document
(FDD)
franchisee
Franchise Rule
franchising
franchisor
master licensee
multibrand franchising
multiple-unit ownership
nondisclosure agreement
piggyback franchising
product and trade name
franchising

Small Business Management Chapter 4 PowerPoint

Recommended

Recommended

More Related Content

What's hot

What's hot (20)

Similar to Small Business Management Chapter 4 PowerPoint

Similar to Small Business Management Chapter 4 PowerPoint (20)

More from LeahBusby1

More from LeahBusby1 (17)

Recently uploaded

Recently uploaded (20)

Small Business Management Chapter 4 PowerPoint